Market timing is not only possible, it is crucial!

Throughout my career, I have heard that it is impossible to time the market. Actually market timing is not only possible, it is crucial! The old rationale behind the impossibility of market timing was often presented with two very impressive sounding notions that convince many of their validity – “Efficient Markets Theory” and “Random Walk Theory”. Perhaps it is the fact that I am a practitioner and not a professional scholar that I can empathize with the difficulty in reading about financial theories, so let us get down to brass tacks – I’ll paraphrase:

The Efficient Market Theory: Everyone in the market already knows every piece of publically available information and has priced that into the market

Random Walk Theory: Investment price movements are random and it is impossible to consistently be successful choosing buy and sell points for individual investments

Essentially, these theories state that whatever your plan is to ‘time the market’, it will not work; however, real-world experience provides a different perspective.

I would like to take you back to 1999, when tech stocks could not go down and life was good. As a career-minded young man working for a financial services firm, I was happy to accept both of these theories. If they were true, then my life was easy – 60% stocks, 30% bonds, 10% cash – next! If there is no point in trying to time the market, then it was easy to sell products that do not even take into account getting out of the market…then it happened.

I experienced a swift kick in the portfolio in 2000 when the tech bubble began to burst. Out of habit, I relied on my training: “the market declined sharply last month but no one can predict this month”. After a few months of following this oblivious approach, it got worse: “the market declined sharply last quarter but no one can predict this quarter”. At some point, there was no longer a personal urgency about the movements of the market as my growth investments shrunk to near invisibility.

It was impossible not to consider my gut feeling in hindsight, “How come I was pretty sure that I knew that the market was going to continue going down? I should have done something.”

On a long-term basis, the market tends to move in cycles. There are bull markets, bear markets and sideways markets. If you follow the philosophy that you cannot time the market, then you are likely to keep the same portfolio through all three. The result is a portfolio that drifts with the markets. You can only hope the tide is up when you need to liquidate and use the money – not an ideal approach.

Fast forward to 2009 – Timing is everything! (I borrowed that oft-used quote from our firm’s President, Barry Cliff). In many cases, market timing is not only possible, it is crucial. In the 90’s it was all about maximizing the ‘return on your investment’, whereas now investors are clinging to the faint hope of receiving a ‘return of your investment’.

There are many ways to incorporate safety measures into an investment plan, but it is a full-time job to do it well. No single approach provides perfect results. However, when your goal is to avoid the long-term and severe downward trends, there are technical signposts that have helped point the way in the past. I provide the following chart of Moving Averages to give you an example.

Chart 1 – S&P 500 Index ($SPX) 50-Day and 200-Day Moving Averages: Nov 1994 – Nov 2009

This 15-year historical chart includes the 50-Day and 200-Day Moving Averages (MAs) for the Standard & Poor’s 500 index. The MAs provide a means to smooth the volatility price movements for purposes of analyzing trends, determined by the averages of most recent daily S&P 500 values. By comparing the 50-day MA with the 200-day MA, it jumps out that the 50-day MA tends to stay above the 200-day MA during bull markets and dip below it during bear markets. I have placed circles and signals within this chart to give you an idea of how this simple approach can help provide guidance regarding when to be in and when to be out.

This approach (as with any technical approach) is not perfect – the sell and buy signals in 1998, 2004 and 2006 would have had you sell and then buy back in at a higher price, BUT, the benefit of this approach is that it would have given you a signal to get out of the market for much of the 2000-2003 and 2007-2009 severe bear markets. This information should be used carefully. There are always more factors to consider than one technical indicator, such as an appropriate mix of investments and how to choose the most appropriate investment vehicle within the universe of options. As always, please consult a professional before you invest.

If you are intrigued by this chart and wish to learn more about a philosophy that is predicated on changing portfolio constitution to adapt to changing market conditions, I invite you to give me a call (301.588.5000) or send me an email (Jim@AFCAssetManagement.com). I look forward to receiving your feedback and welcome any questions that you have as you navigate the alphabet soup of our industry.

About AFC Asset Management Services, Inc.
AFC Asset Management Services, Inc. (AFC) is a Registered Investment Advisor established in 1985, providing professional money management services through a unique strategy called the Dynamic Asset Allocation (DAA) program. AFC endeavors to maximize investment returns through bull and bear markets by making timely portfolio changes based on current market conditions.

Investment decisions are made according to client risk tolerance and compensation to AFC is by fee only – no commissions. AFC takes pride in their highly personalized service. To learn more or to speak with an AFC Financial Advisor, please call 301-588-5000, email Info@AFCAssetManagement.com or visit our website at www.afcassetmanagement.com.